This is a blog of essays on public policy. It shuns ideology and applies facts, logic and math to economic, social and political problems. It has a subject-matter index, a list of recent posts, and permalinks at the ends of posts. Comments are moderated and may take time to appear. Note: Profile updated 4/7/12

17 July 2011

The Double-Dip Scenario

From the Middle Ages’ Christian Crusaders to the Taliban today, true believers have always caused trouble. So it is with the GOP House Freshman.

As a New York Times article today reports, some are quite prepared to throw the nation into default in order to push their “debt is killing us” ideology. Whether they’re also prepared to destroy their political party in the process, the Times reporters apparently weren’t smart enough to ask. But since the GOP House Freshmen seem to focus far more on abstract ideological goals than the probable consequences of their actions, it’s fair to assume that party seppuku, too, would be no obstacle to acting on their true beliefs.

So it seems a good time to spin out—a little more than I did in a previous essay—the probable consequences of a national default. In that essay, I concentrated on fiscal and financial consequences, including: (1) Uncle Sam’s increasing inability to finance his operations, (2) rising interest rates, (3) money-market funds “breaking the buck” or freezing, (4) capital flight from the US, (5) a falling dollar, and (6) a frenzy of financial gambling and swindling, perhaps leading to another 2008-style derivatives meltdown, this time with no more federal money to bail anyone out.

But there will also be macroeconomic consequences, which I didn’t discuss. As David Leonhardt of the Timesreported today, the American consumer is spent. Among the evidence he adduced are the following facts: (1) fewer cars will sell this year than ten years ago, when we were in recession; (2) sales of ovens and stoves are at their lowest level since 1992; (3) home sales have regressed to their lowest post-crisis level; and (4) a recent New York Fed study reported a fall in discretionary spending of 7%, as compared to a maximum fall of 3% in every previous recession.

The causes of this deep retrenchment in consumer spending are obvious. Over fourteen million Americans don’t have jobs. Around about 26 million are unemployed, underemployed or no longer looking for work. Many millions more are afraid of losing their jobs and therefore saving for a rainy day. Still more millions are saving to reduce the debt that supported their pre-2008 consumption binge. And tens of millions have houses that are losing equity or “under water” and so can’t rely on home equity for spending or financial security.

Now, think what would happen upon a default. Millions of households would stop receiving Social Security, military pay, Medicare and Medicaid assistance, and other federal assistance. What would they do? They would stop spending on anything discretionary and would focus on absolute necessities. The drop in discretionary spending would impact businesses almost immediately, causing many to delay hiring or lay off workers, making more people unemployed and reducing aggregate discretionary spending still further.

This vicious circle would be bad enough if it just lasted a month or two, while Congress came to its senses. But suppose the new GOP House members stuck to their extremist ideology and insisted on drastic cuts in Social Security and Medicare—without any increase in tax rates or any reduction in tax loopholes and subsidies—as ransom for saving the nation. Discretionary spending would nosedive for the two, three or more months that it took posturing politicians to patch together some agreement and extend the debt limit.

Some businesses might have the guts to keep a steady course, on the theory that sanity would eventually have to return. But many would not. They would cease hiring, and many would lay off employees to better weather the storm. The resulting vicious circle would almost certainly throw us into another recession.

Now think of what will happen on the upswing, when the crisis at last ends. What will people already living on the margins do, after being deprived of all income for several months, when the money tap suddenly turns on again? Will they spend on manufactured items, on things, discretionary or not?

Hardly. They will first bring their rent or mortgage up to date so they still have a home. Next they will pay past-due utility bills, so their lighting and heating (or air conditioning, it it’s still late summer) won’t stop. Then they will replenish their larders and their nutrition. Many old folks will switch back from dog food to people food. Finally, if they have any money left over, they will spend it on long-neglected medical and dental care. Consumer “discretionary” spending on such things as cars, clothing, and manufactured items won’t revive for months, maybe even a year. By that time unemployment will have soared from its present dismal state.

So there is a good chance that a default, in additional to destroying the global financial system, will throw the US into a real depression, as bad or worse than the Great Depression. And as the US goes, so (unfortunately) goes the rest of the world, possibly even including China.

As you fall asleep tonight, dream of Michelle the Moron (Bachmann, not Obama!) saying that a default won’t be all that big a deal. And try not to have nightmares.

0 Comments:

Links to this post:

About Me

This blog reflects a quarter century of study and forty years of careers in science/engineering (7 years), law practice (8 years) and law teaching (25 years). A short bio and legal publication list appear here. My pre-retirement 2010 CV appears here.
As I get older, I find myself thinking more like an engineer and less like a lawyer or law professor. Our “advocacy” professions—law, politics, public relations and advertising—train people to take a predetermined position and support it against all opposition. That’s not the best way to make things work—which is what engineers do.
What gets me up in the morning is figuring out how things work and how to make them work better, whether they be vehicles, energy systems, governments or nations.
This post explains my respect for math and why you’ll find lots of tables and a few graphs and equations on this blog. If you like that way of thinking, this blog is for you.